Let's Know Things

This month we talk about the NFIP, private insurance, and storm damage. 

We also discuss floods, wildfires, and sanctions.

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Transcript

The term "general average," in the context of maritime economics and law—but also, at times, in economics and law in general—refers to a principle of spreading out risk.

In essence, if you're shipping a bunch of bananas on a large container ship, and there are a bunch of other containers on that ship filled with toys and computers and avocados and all sorts of other things, the general average principle says that if bad weather strikes and that container ship is tossed around and a bunch of containers fall off the ship into the ocean, that financial loss will be spread around to everyone who bought space on the ship.

So even if the containers filled with your bananas did not fall into the ocean, you'll take a small cut in the profits you reap from the sale of your bananas at their eventual destination, and the same is true of everyone else: the people with toys and computers and other products on that vessel will all pay a little so the person or people who lost all their stuff, who suffered the most direct losses, won't be bankrupt because of this unusual event; a risk that everyone knew was a possibly, but hoped wouldn't happen to them.

This concept of spreading out risk so that if something bad happens it will hurt everyone a little, but no one a lot, and perhaps at a business-killing level, goes way way back in history—in a proto-sense to the Code of Hammurabi in the mid-1700s, BC, and in a more modern sense on the island of Rhodes somewhere around 1000 to 800 BC, which is thought to have informed similar policies throughout the Mediterranean world in the late BCs into the early AD centuries; especially during periods of near-frantic maritime warfare, where the shipping of goods over water was perilous because of all the military or pirate activity in the region.

These older policies seem to have fallen into disuse after the fall of Rome, and though some regional and business-by-business arrangements were utilized in the meantime, it wasn't until some older maritime laws from long-ago-fallen Rome were discovered and reimplemented that the general average concept was reintroduced into formal law, especially in the 1400s with the emergence of the Hanseatic League up in Northern Europe, throughout the Baltic region, and in other parts of modern day Scandinavia.

King Louis the 14th of France further chiseled this idea into law in the late-17th century, which then went on to inform default maritime law throughout the rest of Europe.

The York Antwerp Rules, established in 1890, lashed together a bunch of policies that were already in play, including the law of general average, to establish who pays what when cargo is jettisoned, usually for the purposes of keeping a ship upright in a life-threatening storm situation, or to escape a pirate or unfriendly military vessel.

The idea is that the cargo tossed overboard would allow the ship's crew to survive, and in the moment, when time is of the essence, they wouldn't be able to stop and make sure they're chucking the same number of crates for all their clients, to spread out the damage, so these rules set out formal means by which all those involved would pay to ensure everyone took the same risk, and those who lost physical cargo would be made whole, after the fact.

These rules have been updated several times over the years, and are still in effect, today.

But beyond the world of maritime shipping policies, the law of general average has gone on to shape much of the structure of the modern world because of how fundamental it is to the concept of insurance.

What I'd like to talk about today is how insurance is changing, and what those changes might mean for the future of where we live and how we engage with each other, internationally.

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The article I'd like to start with today comes from E&E News, and it's entitled:

‘This is not a survivable market.’ Insurance crisis hits Fla.

This piece looks at some of the insurance companies that, in the mid-20-teens, decided to expand into the US south, including the burgeoning markets of Texas, Louisiana, and Florida.

Following major storms in these areas in 2020 and 2021, many of them have since rethought their decisions, even to the point of pulling out of these areas.

One such company, FedNat Insurance, recently—at the tail-end of June—cancelled 68,200 homeowners insurance policies in Florida.

As a consequence of this and similar pull-backs from private insurance companies throughout the region, state-run insurance companies of last-resort, like Citizens' Property Insurance in Florida, have been deluged with new sign-ups.

Citizens' Property Insurance went from about 420,000 policies in 2019 to around 883,000 last May—more than double.

Citizens' has been trying, for years, to push people off the program into privately-run insurance policies, to deflate their roster and basically free up resources for the really troublesome cases that no other companies will touch, but more and more properties throughout these regions are becoming untouchable in that way; the risks of truly devastating weather events are increasing at a staggering rate, and when a hurricane or similar event knocks out entire neighborhoods all at once, that can wipe out an insurance company's bank account: they make money when they take in more in policy payments than they pay out to folks who've had their properties destroyed.

The math, then, if you're a private insurance company wanting to make a profit, is no longer favorable in areas that are seeing heightened risks of larger and larger weather events, like much of the Gulf Coast of the US.

Important to note here is that this risk is not evenly distributed: in the case of Citizens' Property Insurance, about $141 billion of their $294 billion of total exposure—the amount they might have to pay out if all their covered properties were to be hit at once—is in just three counties: Broward, Miami-Dade, and Palm Beach. Those counties only account for 28% of the state's population, but account for nearly half of their insurance exposure.

These last-resort insurance options, which are usually government-run, are not ideal for insurance-holders either, as they typically don't provide all the bells and whistles and high-end payout guarantees of pricier, private insurance options.

Those who wish to keep their private insurance in areas that haven't been blacklisted, however, have been seeing premium rate-increases, in some cases increases of 30-100%.

That sometimes means a homeowner's insurance payments cost more than their mortgage, making living in extreme weather-threatened areas an increasingly costly proposition, but one without an easy solution for folks who've bought into the area, and who're thus financially stuck, or those who don't want to leave for other—maybe historical, maybe professional, maybe cultural, maybe just temperature-preference-related reasons.

This is just one example of a growing international problem related to what are called "insurance gaps," which in this context means assets that are not covered, or not sufficiently covered, and which are therefore at significant risk of being wiped out if something like a big storm or hurricane or earthquake or whatever else destroys them.

Such gaps represent threats to whole regions because, if someone loses a house but receives an insurance payment for that house, they're made whole and can move forward. If not, and especially if that's their only home—their residence, rather than an investment property—that person is now maybe impoverished, which goes on to negatively impact their social lives and health and professional wherewithal, but also negatively impacts state social programs, and even tax hauls in the region, because that person is probably costing the state money, rather than paying back into the state's coffers.

The same is true on a less human-centric level when the properties are investment properties or rentals: the businesses behind these assets may no longer pay into the system like before, which is an effect that can compound massively when you scale that issue up to many people and many businesses, perhaps all at once.

Whereas with properly run insurance programs, then, disasters suck horribly, but things are eventually rebuilt, lacking such funds tucked away for this purpose, stuff is destroyed and then just sits there, maybe for a long time. Local value is wiped out maybe permanently.

Florida is being seen by some analysts as a bellwether state that portends the concerns to which other states should be paying attention, climate-wise.

Wildfire-prone areas are increasingly being seen as similarly high-risk areas, and thus may soon suffer the same private-insurance-flight as Florida's storm-afflicted and coastal flood-risk areas.

So states that experience regular droughts, or which will soon, and which see regular wildfires already—like Utah, Arizona, Nevada, California, New Mexico, Colorado, and Oregon—may have to deal with similar problems in the near-future, which in turn could leave a lot of assets and infrastructure under- or un-protected by insurance, which means many of those assets and infrastructural elements could disappear, essentially overnight, in the wake of a fire, leaving locals without resources and the state increasingly overburdened and resource-drained.

Alongside coastal storms and wildfires, though, flooding—mostly of the river variety, but also of the coastal variety—is becoming an increasingly pressing issue across dozens of US states.

At the moment, 21 states don't have any laws in place requiring property sellers to disclose previous flooding to buyers, or whether the home or building has even suffered water damage in the past. They also don't have to disclose any information about flooding-potential, like whether the property is on a flood plain and/or in range of a local river's near-future flooding trends.

In the US, only about 20% of homes at risk for flooding are covered by flood insurance.

Most private insurance companies do not even offer flood insurance, because the math just isn't favorable for them, if they want to earn a profit, which they do; it just floods too often in the afflicted areas, and the costs of the damage sustained is too high for them to stomach.

Consequently, the US government created the National Flood Insurance Program, or NFIP, in 1968, which acts as an insurer of last resort for most flood-prone areas in the US, while also restricting building on floodplains—though it arguably performs that latter-task less successfully than the former.

The NFIP insures about 5 million homes, primarily in Texas and Florida, and it hasn't been self-sustaining since 2004—mostly because of the steady drumbeat of devastating weather events, including Hurricane Katrina and Sandy.

The NFIP, as of late-2021, owes the US Treasury more than $20.5 billion due to that deficit: like private insurance companies, the NFIP is unable to make a profit, or even pay its bills, using just insurance payments from folks who make use of it in flood-prone areas.

Unlike private insurance companies, though, the NFIP cannot pull out of these areas, and thus pays out a whole lot more to people in these areas than it receives in insurance payments; and that deficit is increasing each year, as severe weather events become more common due to human-amplified climate change.

The problem has gotten so bad that the US Biden administration has recently proposed an overhaul of this program, in order to recalibrate it toward different purposes and a new climate-reality. One of the proposed changes would prevent the NFIP from offering insurance to builders wanting to construct new homes in risky areas—so they could still build in those areas if they could convince a private insurance company to cover them, but they would no longer have the NFIP to rely upon, which would, in practice, almost certainly mean less building in flood-prone regions, because flood insurance is required to build in most of these areas.

Folks who have received insurance payouts from the NFIP multiple times would also be at risk of losing their insurance under these changes; the idea being that they're draining the program by continuing to live in these risky regions, and are thus receiving a disproportionate amount of available funds; after the fourth claim of more than $10,000, they would be dropped from the program, and would either need to find a private insurance company willing to cover them, accept all future risks themselves, uninsured, or move away from these flood-prone areas.

These changes would also disallow the building of any new commercial properties in flood-prone areas.

The upside of such a proposal, if it goes through, would be to significantly reduce new building on coastal and other flood-prone areas and to potentially make the NFIP self-sustaining again; which would allow it to be used by those who truly need it because of their unusual circumstances, rather than allowing it to be tapped by folks who simply refuse to leave afflicted regions because they know they can keep getting payouts when they suffer weather-related damage.

The short-term impact of this could be significant and painful; as I mentioned, only 20% of homes are covered by flood insurance, and research has shown something like 33% of people believe their standard insurance covers floods—which it does not.

Recent flooding in the area around Yellowstone National Park illustrates something of what we might expect if NFIP coverage is pulled from more properties: only 3% of residents in the area have federal flood insurance, currently, so there are going to be some huge losses in the region, and probably a lot of people moving away, as a consequence.

That could happen in more places, soon, if NFIP protection is pulled as part of an effort to nudge people away from such regions.

So that's kind of the idea; it will suck in the short-term, and people will have to basically migrate away from disaster-prone regions, but in the longer-term that's expected to be a good thing: less risk, less exposure by insurance entities, and consequently, less vulnerability for the government—and insurance companies, and individuals—as a whole, which in turn makes everyone who's covered more sustainably protected, because there's less overall risk to spread out.

One more interesting point worth making here is that insurance is changing in its geopolitical utility, as well, not just in its potential to incentivize and disincentivize living and building trends for the severe-weather-heavy present and future.

Following Russia's invasion of Ukraine, the EU and US slapped a flurry of sanctions and other restrictions on the Russian government and Russian companies and individuals.

One of these moves was related to insurance—and more specifically, maritime insurance.

Russia is an energy resource powerhouse, and its economy is sustained primarily by the export of raw materials like oil and gas and coal.

European and US-based insurers, which dominate the marine-shipping insurance market, are now hesitant to deal with Russian companies and their vessels, and some have even stopped insuring vessels from other countries that are carrying Russian crude oil.

As a consequence, Russian companies and the Russian government are taking on more risk every time they ship something internationally, and in some cases aren't even allowed to utilize international docks and other maritime infrastructure because of that lack of insurance: no one wants to work with them and risk possible damage to their own assets.

There are other insurers available in other countries, but they tend to cost a lot more and have less high-end reputations: the insurers in the EU and US are what most companies go with because they've been around a long time, are easy to work with, and benefit from scale, resources, and sturdy relationships.

These other entities also provide insurance, then, but it's kind of like buying a cheap off-brand of a high-end product: it's technically the same thing as the real-deal, but isn't really the same thing in terms of quality.

This dominance is reinforced by the EU and US's not-quite absolute, but close, control of what's called the reinsurance market.

Reinsurance is insurance purchased by insurance companies from other companies.

So if a small insurance company takes on a contract they wouldn't be able to pay out themselves, if required, they can buy insurance from a larger insurance company, or a company that specializes in reinsurance, and that contract functions similarly to an insurance contract, except that instead of paying out when a house floods or warehouse burns down, it pays out when that large insurance contract pays out.

In practice, that means a Russian vessel hauling oil might want to buy insurance on a shipment they're making, and they'd go with a smaller insurance company operating out of Vietnam, because they can't access insurance markets in the West, but that company in Vietnam wouldn't be able to pay out the full insurance cost if something happened to the ship—so they would take on a reinsurance contract from a Western firm, because again, that market is controlled largely by EU and US companies.

This complicates things for Russia, because the reinsurance market, too, is increasingly unwilling to deal with Russian entities or products; so if they discover what they're reinsuring falls into that category, they might boost the price sky-high to account for that additional regulatory risk, or they might decline to take on the contract to begin with.

This aspect of these sanctions is not a perfect weapon against governments like Russia, then, but they're more effective than many other types of sanction—and that's especially true in a geopolitical world in which so many entities are entangled by these types of contracts.

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Show Notes

https://www.eenews.net/articles/this-is-not-a-survivable-market-insurance-crisis-hits-fla/

https://www.investopedia.com/terms/y/york-antwerp-rules.asp

https://en.wikipedia.org/wiki/General_average

https://en.wikipedia.org/wiki/Insurance

https://filterbuy.com/resources/states-impacted-by-wildfires/

https://en.wikipedia.org/wiki/National_Flood_Insurance_Program

https://sgp.fas.org/crs/homesec/R44593.pdf

https://grist.org/housing/bidens-new-vision-for-the-national-flood-insurance-program/

https://www.eenews.net/articles/biden-admin-stop-flood-insurance-for-new-risky-homes/

https://www.axios.com/2022/06/17/montana-yellowstone-insurance-flood-flooding

https://www.reuters.com/markets/commodities/russian-oils-achilles-heel-insurance-2022-05-25/

https://oilprice.com/Energy/Energy-General/Insurance-Ban-Is-The-EUs-Biggest-Blow-Yet-To-Russian-Oil-Exports.html

https://www.cnbc.com/2022/06/01/tough-new-sanctions-on-russian-oil-could-change-the-opec-dynamic.html

https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/oil/061522-russian-seaborne-oil-exports-could-find-ways-round-eu-insurance-ban-sources

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